Retirement and Qualified Domestic Relations Orders

Distributions to Alternate Payees

Pursuant to a qualified domestic relations order (QDRO), an alternate payee who is a spouse or former spouse of a participant is treated as the distributee (and therefore, subject to tax as if the spouse were the participant receiving a plan distribution) of any distribution received under the order. 420 This is an exception to the general tax principle that income is taxable only to the taxpayer earning the income. It appears that distributions to other alternate payees (for example, children of the participant) are taxable to the participant.

/Footnote/ 420 §402(e)(1)(A). See Clawson v. Comr., T.C. Memo 1996-446 (Federal law determines tax liability, not parties' agreement in state QDRO).

The participant's cost basis in his interest in the plan is allocated ratably between the amount paid to a spousal alternate payee and any other benefits under the plan to which the participant may be entitled. 421 If the alternate payee is not a spouse or a former spouse, basis is not allocated and may be recovered only by the participant under the usual annuity basis recovery rules. The rollover rules described above apply to an alternate payee who is a spouse or former spouse of a participant. 422 Thus, for example, such an alternate payee can choose to have an eligible rollover distribution paid in a direct rollover to an IRA or qualified plan. 423

/Footnote/ 421 §72(m)(10).

/Footnote/ 422 §402(e)(1)(B).

/Footnote/ 423 Thus avoiding mandatory income tax withholding. See Regs. §1.402(c)-2, Q & A-12(a).

Forward averaging, if applicable, is also available for distributions to an alternate payee who is a spouse or former spouse of the employee. (Note that the Small Business Jobs Protection Act of 1996 (SBA), repealed five-year averaging for lump-sum distributions from qualified plans for taxable years beginning after December 31, 1999). 424 Specifically, if a distribution of the balance of the credit to an employee would constitute a lump sum distribution, then a distribution of the balance to the credit of such an alternate payee under a qualified domestic relations under (QDRO) will also constitute a lump sum distribution. In determining whether the distribution consists of the balance to the credit of the alternate payee, only the interest of the alternate payee is taken into account. 425

/Footnote/ 424 §402(d)(4)(J).

/Footnote/ 425 See P.L. 104-188, §1401, amending Code §402(d).

Definition of QDRO

A QDRO must be a domestic relations order, i.e., it must relate to child support, alimony payments or marital property rights for a spouse, former spouse, child or other dependent of the participant (such a person is called an "alternate payee"). The order must be issued pursuant to a state domestic relations law (including a community property law). 986

/Footnote/ 986 §414(p)(1)(B).

Note: However, in Ablamis v. Roper, the Ninth Circuit held that state court probate orders are not QDROs; thus, ERISA preempted and precluded a testamentary transfer by a deceased spouse of her purported community property interest in her surviving spouse's pension benefits. 987 In addition, in accordance with Ablamis and Darby v. Comr., 988 the Tax Court has held that absent a valid QDRO directing payment of a portion of a lump sum distribution, Louisiana community property law should not be considered in determining whether taxpayer's former wife was a distributee of one-half of the distribution from taxpayer's pension plan. 989 In Powell v. Comr., however, the Tax Court distinguished Ablamis, Karem, and Darby, in finding that a former spouse was the distributee of pension benefits awarded pursuant to a California divorce decree. It explained that Darby recognized an exception in respect of ownership of pension benefits under California community property law because its statement that a distributee had to be a participant or beneficiary was not an exclusive definition of the term. 990

/Footnote/ 987 937 F.2d 1450 (9th Cir. 1991).

/Footnote/ 988 97 T.C. 51 (1991).

/Footnote/ 989 Karem v. Comr., 100 T.C. 521 (1993).

/Footnote/ 990 101 T.C. 489 (1993),

A domestic relations order must create or recognize an alternate payee's right to, or assign to an alternate payee the right to, plan benefits as to a plan participant in order to constitute a QDRO. 991 The domestic relations order need not mimic the language of the statute as long as the criteria of the statute is satisfied in substance. 992

/Footnote/ 991 §414(p)(1)(A)(i).

/Footnote/ 992 Hawkins v. Comr., 86 F.3d. 982, 20 EBC 1513 (10th Cir. 1996), rev'g 102 T.C. 61, 17 EBC 2653 (1994). See also In re Boudreau, No 93-9491-8G3 (Bankr. M.D. Fla. 1/9/95) (Final judgment of divorce that fails to name alternate payee or to specify the number of payments as required by §414(p) is not a qualified domestic relations order).

Note: In Hawkins v. Comr., 993 the Tenth Circuit found the Tax Court's reading of QDRO statute to be unduly narrow for two reasons: (1) it erroneously assumed that to create a QDRO, the parties to an agreement must express their intent to reallocate the tax burden of a pension distribution; and (2) it read into the QDRO rules a requirement that the parties incorporate the exact statutory terminology when drafting a domestic relations order. The Tenth Circuit held that nothing in the statute requires the parties to a marital settlement agreement to indicate unambiguously their desire to shift the tax consequences of a particular distribution. The court also found that the QDRO rules do not require the parties to a domestic relations order to employ the term "alternate payee" in order to create a QDRO. It found that the statute merely requires the parties to execute a document which either "creates," "recognizes," or "assigns" rights under a qualifying plan to an alternate payee.

/Footnote/ 993 86 F.3d. 982, 20 EBC 1513 (10th Cir. 1996), rev'g 102 T.C. 61, 17 EBC 2653 (1994).

For the domestic relations order to be "qualified" (i.e., to be a QDRO, which can be enforced), it must specify certain facts:

• the name and the last known mailing address (if any) of the participant and the name and mailing address of each alternate payee covered by the order;

• the amount or percentage of the participant's benefits to be paid by the plan to each such alternate payee, or the manner in which such amount or percentage is to be determined;

• the number of payments or the period to which the order applies; and

• each plan to which the order applies. 994

/Footnote/ 994 §414(p)(2). See also Notice 97-11, 1997-2 I.R.B. 50, setting forth sample QDRO language.

Statutorily mandated by the Small Business Job Protection Act of 1996 (SBA), 995 Treasury developed sample language for a qualified domestic relations order (QDRO), which satisfies the requirements of a QDRO. 995.1

/Footnote/ 995 See P.L. 104-188, §1457.

/Footnote/ 995.1 Notice 97-11, 1997-2 I.R.B. 50. For text of the sample language, see ¶5520.1300, below. The IRS stated that Notice 97-11 is not intended to convey interpretations of the statutory requirements applicable to QDROs, but only to provide examples of language that may be used in drafting a QDRO. The sample language addresses a variety, but not all, matters and retirement benefit issues. Some of the sample language is not necessarily required for the order to satisfy QDRO requirements. The IRS made clear that alternative formulations would be permissible for use in drafting orders that meet the statutory requirements for a QDRO.

In addition, to qualify as a QDRO, an order must stay within certain bounds prescribed by the Code to protect the plan. In general, it must not require the plan to provide any form or type of benefit or option not otherwise provided under the plan; it cannot require the plan to provide higher benefits (determined on an actuarial basis) than otherwise provided; and it cannot require the payment of benefits if those benefits are required to be paid to another person already pursuant to a previous QDRO (such as a former spouse). 996

/Footnote/ 996 §414(p)(3).

A QDRO may require some acceleration of payments in addition to that allowed in the plan document. Specifically, an order may require that benefits begin being paid on the earlier of:

• the date on which the participant is entitled to a distribution under the plan; or

• the later of:

(a) the date the participant reaches age 50; or

(b) the earliest date on which the participant could begin receiving benefits under the plan if the participant separated from service. 997

/Footnote/ 997 §414(p)(4)(B).

A QDRO may give the former spouse of a participant the rights of a spouse of the participant under the rules applicable to qualified joint and survivor annuities and qualified pre-retirement survivor annuities. 998 As a result, the order may require that the former spouse consent before the participant can receive his retirement benefit in any form other than a joint and survivor annuity (with the former spouse receiving the survivor's annuity) or pay a death benefit in any form other than an annuity for the benefit of the former spouse.

/Footnote/ 998 §414(p)(5).

¶5520.1300 Notice 97-11

Sample QDRO Language

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PART II. SAMPLE LANGUAGE FOR INCLUSION IN QDRO

A. SAMPLE LANGUAGE FOR IDENTIFICATION OF PARTICIPANT AND ALTERNATE PAYEE

The "Participant" is [insert name of Participant]. The Participant's address is [insert Participant's address]. The Participant's social security number is [insert Participant's social security number].

The "Alternate Payee" is [insert name of Alternate Payee]. The Alternate Payee's address is [insert Alternate Payee's address]. The Alternate Payee's social security number is [insert Alternate Payee's social security number]. The Alternate Payee is the [describe the Alternate Payee's relationship to Participant] of the Participant.

B. SAMPLE LANGUAGE FOR IDENTIFICATION OF RETIREMENT PLAN

This order applies to benefits under the [insert formal name of retirement plan] ("Plan").

C. AMOUNT OF BENEFITS TO BE PAID TO ALTERNATE PAYEE

Instruction: The QDRO should clearly specify the amount or percentage of benefits assigned to the Alternate Payee or the manner in which the amount or percentage is to be determined, and the number of payments or period to which the Order applies. There are many different forms in which benefits may be paid from a qualified plan. Because of the diversity of factors that should be considered, and the need to tailor the assignment of benefits under a QDRO to meet the needs of the parties involved, specific sample language regarding the assignment of benefits has not been provided.

D. SAMPLE LANGUAGE FOR FORM AND COMMENCEMENT OF PAYMENT TO ALTERNATE PAYEE

Instruction: Drafters using the separate interest approach may use paragraph 1. Drafters using the shared payment approach may use paragraph 2. Drafters using the separate interest approach for a portion of the benefits allocated to the alternate payee and the shared payment approach for the remainder should modify the sample language to specify the benefits to which each paragraph provided below applies.

• 1. Separate Interest Approach

The Alternate Payee may elect to receive payment from the Plan of the benefits assigned to the Alternate Payee under this Order in any form in which such benefits may be paid under the Plan to the Participant (other than in the form of a joint and survivor annuity with respect to the Alternate Payee and his or her subsequent spouse), but only if the form elected complies with the minimum distribution requirements of Section 401(a)(9) of the Internal Revenue Code. Payments to the Alternate Payee pursuant to this Order shall commence on any date elected by the Alternate Payee (and such election shall be made in accordance with the terms of the Plan), but not earlier than the Participant's earliest retirement age (or such earlier date as allowed under the terms of the Plan), and not later than the earlier of (A) the date the Participant would be required to commence benefits under the terms of the Plan or (B) the latest date permitted by Section §401(a)(9) of the Internal Revenue Code. For purposes of this Order, the Participant's earliest retirement age shall be the earlier of (i) the date on which the participant is entitled to a distribution under the Plan, or (ii) the later of (I) the date the Participant attains age 50, or (II) the earliest date on which the Participant could begin receiving benefits under the plan if the Participant separated from service.

• 2. Shared Payment Approach

The Alternate Payee shall receive payments from the Plan of the benefits assigned to the Alternate Payee under this Order (including payments attributable to the period in which the issue of whether this Order is a qualified domestic relations order is being determined) commencing as soon as practicable after this Order has been determined to be a qualified domestic relations order or, if later, on the date the Participant commences receiving benefit payments from the Plan. Payment to the Alternate Payee shall cease on the earlier of: [insert date or future event, such as the Alternate Payee's remarriage], or the date that payments from the Plan with respect to the Participant cease.

E. SAMPLE LANGUAGE FOR TREATMENT OF FORMER SPOUSE AS PARTICIPANT'S SPOUSE

Instruction: The Alternate Payee may be treated as the Participant's spouse only if the Alternate Payee is the Participant's spouse or former spouse, and not if the Alternate Payee is a child or other dependent of the Participant. If the Alternate Payee is the Participant's spouse or former spouse, drafters may select sample paragraph 1, sample paragraph 2, or sample paragraph 3. Sample paragraph 1 applies if the Alternate Payee is treated as the Participant's spouse for all of the spousal survivor benefits payable with respect to the Participant's benefits under the Plan. Sample paragraph 2 applies if the Alternate Payee is treated as the Participant's spouse for a portion of the spousal survivor benefits payable with respect to the Participant's benefits under the Plan. Sample paragraph 3 applies if the Alternate Payee is not treated as the Participant's spouse for any of the spousal survivor benefits payable with respect to the Participant's benefits under the Plan.

• 1. Alternate Payee Treated as Spouse For All Spousal Survivor Benefits

The Alternate Payee shall be treated as the Participant's spouse under the Plan for purposes of Sections 401(a)(11) and 417 of the Code.

• 2. Alternate Payee Treated as Spouse For a Portion of the Spousal Survivor Benefits

The Alternate Payee shall be treated as the Participant's spouse under the Plan for purposes of Sections 401(a)(11) and 417 of the Code with respect to [insert percentage of benefit or a formula, such as a formula describing the benefit earned under the plan during marriage].

• 3. Alternate Payee not Treated as Spouse